The Neglected Pharmaceutical Supply Chains

Pharmaceutical companies have long been considered the laggards of supply chain 'best practice.' Given their huge profits from proprietary blockbuster drugs, these companies have always made product availability a greater priority than supply chain efficiency. In the past, pharmaceutical companies have neglected supply chain management because its costs are insignificant compared with sales and marketing or research and development (R&D). But now, a number of factors are putting pressure on pharmaceutical companies to change their traditional ways of doing business, which include the following:

• Increased competition from generics cutting into the revenues of blockbuster drugs coming off patent.

• Reference pricing and shorter patent life cycles driven by "fast followers" further eroding profits.

• As pressure increases to reduce health care costs, some governments are refusing to pay the high price of new drugs and threatening to limit reimbursement levels.

• Industry consolidation and a proliferation of products are leading to greater complexity overall, particularly factoring in language and dosage variances among different countries.

• In some areas of the market, such as generics, the supply chain is becoming a source of competitive advantage

These factors are driving pharmaceutical companies to finally focus on improving supply chain efficiencies as a means of optimizing operating margins and financial performance. The good news is that the potential for improvement is significant.

Inventory management

One key area is inventory management. Compared with other industries, and even other process industries, pharmaceutical companies tend to have extremely high levels of inventory. This is primarily because of the high profits and product-driven focus of the industry, which make non-availability of products unacceptable. To avoid the risk of running out of stock, pharmaceutical companies have historically created security cushions in the form of high inventory levels. Moreover, in addition to a company-held inventory, wholesalers maintain as much as 2 months' supply of stock in their own warehouses.

Figure 1: Order characteristics driving supply chain design.

Within the industry, it is not unusual to find inventory turns of only one or two times per year, compared with double-digit turns in the electronics industry. Exacerbating the problem is the number of local warehouses that pharmaceutical companies have traditionally maintained, either to facilitate fast cross-border delivery in the face of border restrictions to offset the lack of cost-efficient, reliable cross-border carriers, or to satisfy past regulatory requirements that no longer exist. To solve these problems, pharmaceutical companies can consolidate their warehouse functions for potentially significant savings and better product availability, and minimize the likelihood of having the wrong inventory in the wrong place at the wrong time.

Other factors are facilitating these changes; now that Europe is moving towards a single market, with falling trade barriers and a single currency, a number of cross-border service providers are emerging. Combined with newly developing electronic networks, these changes are encouraging collaboration across borders and across companies throughout the supply chain.

One size does not fit all

Before undertaking any supply chain initiatives, a pharmaceutical company must first analyse the differing needs of its customers. In PRTM's experience, companies that adjust and differentiate their supply chains based on certain product or market characteristics can become much more efficient than companies that try to satisfy all their customers with a single structure and process. This means that pharmaceutical companies must recognize that an original equipment manufacturer (OEM) license partner, a supermarket chain ordering off-the-shelf products and a wholesaler of prescription drugs all have different needs - and a one size fits all supply chain cannot address them all efficiently and effectively.

Table I: Characteristics of supply chain types, driven by product and customer requirements.

Important factors

A number of key drivers help determine the best supply chain structure for different customers. These drivers include order fulfilment lead-time, order frequency, order complexity (the number of stock keeping units [SKUs] per order), product shelf-life, order volume and stability of demand. Other considerations include the business models and players in the downstream supply chain and their level of supply chain maturity. By designing multiple supply chains to align these different requirements, companies can realize major improvements in product availability, cost savings, error reduction and asset utilization.

For example, a customer that orders bulk drugs 3 months in advance can be serviced with an order-driven supply chain with no finished inventory on hand. By contrast, products for a hospital that need small quantities shipped at short notice could be produced on a made-to-stock, ready-to-ship basis. Figure 1 illustrates different customers and channels - their order size, order frequency and order complexity, three of the characteristics that drive supply chain design. These characteristics should determine the set-up of a company's order fulfilment operations and processes.

Table II: Best practice design principles.

Supply chain formats

Working with pharmaceutical clients throughout Europe, we have observed the emergence of three supply chain types, each distinguishable by its product delivery time requirements:

Rapid. The rapid supply chain is for customers requiring delivery in 24 hours or less, such as hospitals on a direct delivery schedule, or diagnostics companies with urgent needs for supplies or spare parts. For pharmacies needing rapid delivery of products, pharmaceutical companies may outsource delivery to wholesalers that hold inventory.

Next day. The next day supply chain is currently the standard delivery time in the diagnostics business and for wholesale suppliers, but hospitals also sometimes require next day delivery.

Relaxed. The relaxed supply chain is for bespoke formulations, for customers such as health care organizations. These formulations often require 6–8 weeks to develop and deliver.

The typical pharmaceutical company has a variety of customers and must meet all three types of delivery need. The different characteristics of these three supply chain types are outlined in Table I.

Product type and customer expectations must drive a company's supply chain design. Products requiring next day delivery, such as certain drugs or products with a short shelf life, are usually made to stock and held in decentralized warehouses that are closer to the customer. Accurate demand forecasting is critical for these relatively perishable products.

Most pharmaceutical companies have customers with different needs and attempts to satisfy these requirements with a single supply chain usually leads to higher costs and a mismatch in service level for certain goods. Multiple supply chains, by contrast, would serve customers effectively.

Structure

Each supply chain should be structured in a way that best meets customer needs. Inventory warehouses, processes and personnel must be planned accordingly. Table II shows examples of differing design best practices across the different supply chains.

Benefits

Pharmaceutical companies that move from an average to a well-managed supply chain, particularly multiple supply chains tailored to specific customers, gain major benefits:

Better customer service. On-time delivery is a critical component of customer service. Delivery problems often lead to stock shortages, which can result in sales lost to alternative products and the risk of lost customers. Companies that match delivery to customers' specific requirements through tailored supply chains can greatly improve their on-time delivery record. One pharmaceutical client found that a 5% improvement in delivery performance led to a 1% increase in sales. On-time delivery also boosts cash-to-cash cycle times by speeding up the payment cycle.

Improved product life cycle management. Given the high costs of R&D, pharmaceutical companies must maximize the income from every new product, particularly before patents expire. This means making sure that products are widely available from product launch onward through better supply chain performance. Improving the supply chain results in more effective planning, production, inventory management and delivery scheduling. Moreover, product recalls can be handled more effectively and efficiently through supply chain product tracking.

Lower costs. Pharmaceutical companies can cut their supply chain costs by at least 10-15% through better forecasting, inventory management, and capacity utilization. When supply chain flows are driven by customer needs, the right amount of product is produced at the right time and arrives when needed, largely eliminating safety cushions and other wasteful supply chain practices.

Better inventory management. Inventory reductions of 20-30% are commonplace, particularly when multiple supply chains are adopted. Different supply chains can optimize the volume and mix of inventory, and streamline the number of warehouses needed. High value items such as active pharmaceutical ingredients (APIs) can be produced or bought on an as-needed basis, reducing the capital tied up in stock.

Better capacity utilization. Better planning, scheduling and reduced changeover times can greatly improve capacity utilization and lead to lower overall costs. Companies with more flexible production can align planning, sourcing and inventory levels with specific supply chain needs.

Greater flexibility and efficiency. Pharmaceutical companies can more easily integrate in-licensed and other third party products, and better manage products overall through multiple channels and supply chains. Improved supply chain capabilities also make it easier to manage relationships with supply chain partners such as contract manufacturers, logistics providers and warehouse operators.

Summary

Given the benefits of effective supply chain management, and the industry pressures driving fundamental change for improved pharma operations, a growing number of pharmaceutical companies are rethinking their traditional ways of doing business. Poorly managed pharmaceutical supply chains may soon be a thing of the past.